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Measuring Model Risk

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  • Thomas Breuer
  • Imre Csiszar

Abstract

We propose to interpret distribution model risk as sensitivity of expected loss to changes in the risk factor distribution, and to measure the distribution model risk of a portfolio by the maximum expected loss over a set of plausible distributions defined in terms of some divergence from an estimated distribution. The divergence may be relative entropy, a Bregman distance, or an $f$-divergence. We give formulas for the calculation of distribution model risk and explicitly determine the worst case distribution from the set of plausible distributions. We also give formulas for the evaluation of divergence preferences describing ambiguity averse decision makers.

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  • Thomas Breuer & Imre Csiszar, 2013. "Measuring Model Risk," Papers 1301.4832, arXiv.org.
    • Handle: RePEc:arx:papers:1301.4832
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    Cited by:

    1. Jose Blanchet & Karthyek Murthy, 2019. "Quantifying Distributional Model Risk via Optimal Transport," Mathematics of Operations Research, INFORMS, vol. 44(2), pages 565-600, May.
    2. Postek, K.S. & den Hertog, D. & Melenberg, B., 2015. "Computationally Tractable Counterparts of Distributionally Robust Constraints on Risk Measures (revision of CentER DP 2014-031)," Other publications TiSEM eeb9c898-6943-4199-b747-3, Tilburg University, School of Economics and Management.
    3. Li, Jing, 2018. "Essays on model uncertainty in financial models," Other publications TiSEM 202cd910-7ef1-4db4-94ae-d, Tilburg University, School of Economics and Management.
    4. Postek, K.S. & den Hertog, D. & Melenberg, B., 2015. "Computationally Tractable Counterparts of Distributionally Robust Constraints on Risk Measures (revision of CentER DP 2014-031)," Discussion Paper 2015-047, Tilburg University, Center for Economic Research.
    5. Pichler, Alois & Schlotter, Ruben, 2020. "Entropy based risk measures," European Journal of Operational Research, Elsevier, vol. 285(1), pages 223-236.
    6. Thomas Kruse & Judith C. Schneider & Nikolaus Schweizer, 2015. "What's in a ball? Constructing and characterizing uncertainty sets," Papers 1510.01675, arXiv.org.

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